Market Anomaly - Inflation Expectations
Recently, as of Q3 2016, the derivatives market has begun pricing in low inflation for the foreseeable future. For example, the 50 year U.S. inflation swap rate is currently ~1.88% – indicating that over the next 50 years, the market is approximately expecting an average U.S. inflation rate of 1.88%. This expectation is lower than the historical average U.S. inflation of 3.15% and indicates the market believes there will be less inflation in the future than in the past. This market anomaly may present an opportunity for institutions to hedge inflation risk at historically attractive levels.
Despite all-time low inflation expectations, it is worth acknowledging some structural drivers of lower inflation expectations. On the demand side, aging demographics and the highest levels of debt in history could curb future spending. Conversely, on the supply side, technological innovations could drive lower cost structures for businesses in the future.